Context:
The International Monetary Fund (IMF), in its report titled “India Financial System Stability Assessment,” expresses concerns about the risks of Non Banking Financial Companies (NBFCs) for the financial system of India. The report identified:
- The overexposure of NBFCs to power and infrastructure sectors
- Interconnectedness of NBFCs with other financial markets
- Possible banking risks in case of stagflation
Key Findings
NBFC Risks Due to Power Sector Exposure
- 63% of power sector loans in FY24 came from just three large infrastructure financing NBFCs, rising from 55% in FY20.
- 56% of NBFC lending was financed through market instruments, the remainder by bank borrowings (which have increased since FY19).
- State owned NBFCs (e.g. IREDA) are in even greater risk.
Interconnectedness with Banks & Market Instruments
- With massive reliance on market instruments and bank borrowings, NBFCs become vulnerable to liquidity shocks.
- Any stress on the NBFCs may cause spillover to the entire financial system, affecting banks and investors.
Stagflation Stress Test on Banks
- IMF simulated a stagflation scenario (low growth + high inflation).
- Public sector banks (PSBs) may struggle to maintain the minimum requirement of the 9% Capital Adequacy Ratio (CAR).
- IMF suggests PSBs strengthen capital reserves by retaining earnings instead of paying dividends to the government.
Conclusion & Recommendations
- For NBFCs: Reduce overdependence on power & infrastructure sectors and enhance risk management.
- For Banks: Strengthen capital buffers in order to withstand shocks in case of economic downturns.
- For Policymakers: Ensure financial stability within the purview of NBFC bank linkages and preparations for potential external risks.
Source: TH
